A Troubling 'Head-And-Shoulders' Pattern Is Quickly Developing In The Stock Market

http://en.wikipedia.org/wiki/File:Da_Vinci_Vitruve_Luc_Viatour.jpg A scary head-and-shoulders pattern could be building in the S&P 500, and this negative chart formation would be created if the market stalls just above current levels.

Redler follows the short-term technicals of the market, and he says the head and shoulders should be proven either way in the next few trading days. "Anticipating this type of pattern has been painful this year," he said. The head and shoulders is seen by technicians as a signal of more selling to come.

"The bears are hanging their hat on the idea that this bounce back will lead to a lower high, potentially a right shoulder that continues in the 1575 area," said Redler, describing the pattern after Tuesday's close. "The first pullback of the year was March 20 with the Italian election. The left shoulder was built during the month of March, with the peak being around 1573. Then you had a head when it hit its high at 1597."

Redler said if the pattern forms, the measured move from 1597, or the head, to the neckline would be take it to 1538-1542. The S&P could then move down to 1490-1510. A pivot point could then be 1472.

The S&P 500 slumped 1.5 percent, falling below 1550 Wednesday. It had rebounded Tuesday to 1574, a 22 point or 1.4 percent gain, in a strong reversal after Monday's 2.3-percent decline.

"The right shoulder which started to form yesterday is still in the process. It might not bust through the neckline today or tomorrow but you can see by the chart is it's getting clearly defined," said Redler.

The big market swings reignited the debate about whether stocks will pull back with a decent size correction before moving higher again.The market is also awaiting further news on the Boston Marathon bombings, which sent an already down market to a steep decline Monday.

"I do think what we've seen is a corrective bounce, one that can continue but I don't think it's going to take out the highs that we have made,"" said McNeil Curry, global head of technical strategy at Bank of America Merrill Lynch.

"I don't think we're going to see a push north of (S&P)1597. I think we're going to see new lows before that. I think we could see the 1537/1525 zone. That's the big support level to watch," he said.

Curry also said the move in the VIX, which jumped 43 percent Monday, was significant. The VIX is the Chicago Board of Options Exchange's Volatility Index and it is seen as a measure of market expectations for near term volatility. "Historically when that happens, when you get that kind of move, it often leads to a period of consolidation and then you get a bigger 'risk off' period to follow," Curry said. The VIX, or fear indicator, declined 19 percent Tuesday to 13.96.

Paul LaRosa, market technician at Maxim Group, said the market is far from heading toward a bear market. But he too sees a pullback. "We're a little cautious because we hit our price target. I don't see the type of big gains that happened in the first quarter happening in the second quarter," he said. "It's too hard to say whether this is a major top. I don' think it is."

"The probabilities favor that this market will bounce around in the upper 14,000 to 15,000 area (on the Dow) for the next couple of weeks," he said. "On the S&P, it could probably hit a top around 1600. I don't think it could go much higher than that and probably you could dip to 1525."

LaRosa expects the market to follow the seasonal pattern of the last three years, where a sell off began in April. "Maybe the summer is the time to buy if we come down to the round numbers of 14,000 and 1500 on the Dow and S&P," he said.

Redler said so far the market has been helped this year by investors who step in and buy the dips. Tuesday "was an impressive move. It seems like every time we get a big engulfing down day, where prudent traders take off risk to see if there's going to be follow through, the market doesn't have downside follow through," he said.

"I think both bulls and bears are walking cautiously here,"he said. "There's a big time lack of euphoria even with high prices, which some would say is a reason we are going higher."